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TRANSCRIPT
Re-thinking Directors Duties, Governance
and Regulation
Dr Shann Turnbull
Principal: International Institute of Self-governance
PO Box 266 Woollahra, Sydney, Australia 1350
Cell:0418 222 378
Questions about ethics
As a starting point I would like to seek your
views on ethics
Might the experts here today advise me on the
three questions in red on the next slide ?
3
ETHICAL STANDARDS OF A LAW COURT
Accused
JUDGE
Witnesses
Jury Written statement
being judged Information
Information
Is organisational structure and/or culture important?
2. Is Independence of
mind sufficient
1. Is it ethical for a
Judge to be selected
and paid by the
accused? ?
3. Can such a Judge
state that he is
independent?
4
DIRECTORS
(Accused)
AUDITOR
(JUDGE)
“INDEPENDENT EXPERTS”
(Witnesses)
INVESTORS
(Jury)
ACCOUNTING
STANDARDS
(Legislature)
FINANCIAL REPORTS
Appointed and
briefed by directors
Nominated, managed and paid by
directors who may employ Auditor
for additional services
Directors allocates costs & revenues,
determine the value of stock, debtors
& non current assets and select
accounting policies within or outside
accounting standards
Information
Information
Is it ethical for Auditors to attest they are
“independent”?
Selects
& pays
Is it ethical for directors
to select & pay their
judge?
Governance quiz
A general requirement of the law is for directors to act ethically and in good faith and avoid conflicts of interest.
① Why then do we have governance codes, regulators and laws that force directors into unethical conflicts by forming audit committees to select and pay those who judge their accounts?
② Should not the audit committee be made up of a shareholder appointed committee as proposed by the 1862 UK Act and as occurs in Europe?
Other best practice puzzles
① How can any director be independent of a major shareholder?
② Even without a major shareholder how can any “independent” director obtain the incentive and/or the power to act?
③ How can independent directors who by definition possess less firm specific and/or industry knowledge are best suited to add value or be monitors of management?
④ Can directors carry out their fiduciary duties with due care, diligence and in good faith to monitor management with information provided by management?
⑤ What processes do non-executive directors possess to discover when their trust in management might be misplaced
Network governance found in all living creatures
resolves conflict problems and introduce benefits
① How can ANY director be called “independent” if they are compromised by conflicts with auditors who provide “intelligence” to shareholders for making decisions on how to vote on director pay and/or re-election?
UK Law Lords in the 1990 Caparo case determined that the reason for an audit is governance not economic as forced upon the world by US law and auditors.
① If absolute power corrupts absolutely are shareholders and regulators irresponsible in allowing directors to possess absolute power to corrupt themselves and the business in deciding when they have conflicts of interests and how to manage them? Division of powers in shareholder agreements provide win win solutions.
Puzzle answered by the science of governance
Q. How can creatures with small brains and little intelligence manage to survive in unknowable dynamic complex environments when firms governed by highly intelligent humans with much bigger brains cannot?
A. Because they have:
(i) Network governance that has both top-down and bottom-up control and communications systems, (unlike hierarchies) and,
(ii) They use contrary behavior (inhibited in hierarchies and board-room culture) that provide both checks and balances and also a rich menu of responses to manage risks and opportunities.
The science of governance
MIT mathematics professor Norbert Wiener identified in 1948 a new science that has its own foundations described as “cybernetics” - years after relativity theory.
Wiener defined it as “the science of control and communication in the animal and the machine”.
The science is used for designing automatic elevators, self-regulating machinery, self-governing space probes and explains how DNA has made animals self-regulating and social creatures self-governing by being hard wired to possess contrary behavior to create “Tensegrity”
My PhD research identified how the science can be applied to social organisations to make it the science of governance and to establish a “science of corporate governance” grounded in the natural sciences.
10
Network governance – separation of powers is first step
Shareholders
Management Board
(Executives)
Manages business
(subject to veto of
governors only if
conflict arises)
Governance Board
(Non-Executives)
Control and pay external
and internal auditors,
other advisors, director
nomination & pay. Chair
AGMs
One cumulative vote per share per
director
One vote per investor
Conflicts avoided and/or creditably managed
11
Network governance – Bottom up added to top down
Stakeholder
Congress
Shareholders
Management Board
(Executives)
Governance Board
(Non-Executives)
One cumulative vote per share per
director
One vote per investor
Customers
Councils
Suppliers
Forums
Community
Committees
Employees
Assembly
Chair AGM advise on
Governors, nomination
& pay
NEDs not
conflicted &
obtain info
independent
of mangers
Examples of network governance
12
The sustainable operating and competitive advantages of network
governed are illustrated by:
The John Lewis Partnership is the largest retailer in the UK with
69,000 employees who have been its only owners since 1950. Like
all other non-trivial sustainable employee owned firms it has a
network of boards.
The Mondragón stakeholder owned cooperatives first
established in Spain in 1957 now have over 60,000 employee
owners operating a network of over 200 firms governed by a
network of over 1,000 boards.
Visa International Inc has been owned by its competing
customers since 1976 in the US and has over a hundred boards
each with absolute power over a function or geographic area.
© International Institute for Self-governance Slide No. 13
Disconnected US/UK capitalism
Vs Connected Japanese governance
S = Supplier
Absence of built-in double loop ownership and control networks or top lev el exchange of operational trade intelligence
Monthly and even weekly meetings of keiretsu counc ils and a v ariety of other ne tworks involving executives from bank, trading house, suppliers and customers.
Ownership
C= Customer Trade activity
Anglo (Owners not related)
Volatile without industry
knowledge, resources or incentives to
improve performance
Cu
stom
ers
Sup
pli
ers
S C
S
S
S
C
C
C
Shareholders
Firm
Various banks not involved in
ownership or control (except after failure)
Japanese Keiretsu (Related party owners)
Patient with knowledge, means and
will to improve
performance
Sup
pli
ers
S C
C
C
C
S
S
S
Bank or Trading House servicing
all members
Cu
stom
ers
Shareholders
Firm
Shares iss ued to employees and exchanged with trading partners
Legend
Sourc e: Analytica 1992
Disconnected US/UK capitalism (Lehman) Parties listed
below not
constructively
connected:
Risk mitigation requires constructively connecting A+B+C+D
A
Possess risk
information?
B
Possess the
will to act?
C
Possess power
to act?
D
Possess
capability?
Shareholders 1 No Maybe? No Yes
Directors 2 Inadequate No Yes Yes
CEO/CFO 3 Mostly No Yes Not alone*
Executives 4 Yes No Yes Not alone*
Operational
stakeholders 5 Yes Yes No Not alone*
Commentators 6 Some Probably No No
Regulators 7 Insufficient Maybe? Yes Not alone*
Network-governance competitive
advantages
15
Stakeholder engagement through multiple boards
introduces sufficient complexity to control complexity
(Creates co-regulators to allow amplification of control).
Stakeholder loyalty and commitment to provide cost
effective services to the efficient operations of the firm.
The role of NEDs is legitimatized by them obtaining
feedback from stakeholders on the performance of the
company, its executives and its goods/services
independently of management.
Management obtains access to 90% of” the source of
product innovations from “lead users” (Hippel 1994) and
competitive intelligence.
Network-governance advantages
16
Non- Directors (9)
Auditors (4)
Management (6)
Other stakeholders (4)
Regulators (3)
Advantages of network governance for:
Non-executive directors (NEDs) 1. Role simplified and information overload reduced by the decomposition of decision-
making labor that also minimizes compliance responsibilities;
2. Monitoring and supervisory role legitimatized by obtaining access to a rich variety of
rich information to evaluate management and the business independently of
management;
3. Ability to cross check management reports for errors, biases, omissions and spin;
4. Formal and informal access to industry, product and competitive intelligence and/or
whistle blowers from systematized stakeholder engagement;
5. Creditable processes established on an independent systemic basis for learning when
trust in management might be misplaced;
6. Exposure to most financial liabilities transferred to full time executives;
7. Unethical conflicts with financial auditor eliminated with exclusive control of
internal auditor;
8. Residual conflicts on their own pay and tenure taken over or mediated by stakeholder
congress;
9. Intelligence on Key Performance Indicators (KPIs) provided by stakeholders who
management service.
Advantages of network governance for:
Auditors
1. Unethical conflicts removed by no longer being selected,
appointed and remunerated by the individuals whose
accounts they are judging;
2. Removing questions about auditors not really being
independent of directors and/or management and so the
need to introduce audit partner or audit firm rotation;
3. Access obtained to a rich variety of alternative
communication channels to cross check the integrity of
data independently of management;
4. Remove unconscious bias in audit judgments as revealed
by research into how good people do bad things.
Advantages of network governance for Managers
1. Formal relationships established to facilitate and/or
arbitrate Total Quality Management (TQM) and Just in
time (JIT) processes with relevant stakeholders;
2. Process for accessing innovational, operational and
competitive intelligence from stakeholders that might not
otherwise be provided on a systematic basis;
3. Facilitate stakeholder loyalty and engagement to
constructively support the firm;
4. Systematic process to quickly learn about problems and
take corrective actions before governors;
5. Harness pro-bono stakeholder resources for continuous
improvements;
6. Compliance processes integrated into management
Advantages of network governance for:
Stakeholders
1. Formal access to contribute to continuous
improvement programs for mutual benefits;
2. Direct access to correct poor quality goods/services
and relationships;
3. Direct, quicker and more responsive access to
protect and further their own interest than
regulators, courts of public protests;
4. Strengthen constructive working relationships and
mediate others.
Advantages of network governance for:
Regulators
1. Amplification of regulation through stakeholder
supplementation as co-regulators;
2. Higher integrity of monitoring communications
through multiple stakeholder feedback;
3. Improved formal and informal access to monitor
and control firm compliance;
4. Role changes from directly supervising operations
to promoting and supervising the integrity of firm
self-regulation in protecting public interest.
Systemic problems of
“best” practices for
directors
Systemic solutions from introducing network
governance used by nature
1 Suspicion by outsiders that the
absolute power of directors to
identify and manage their own
conflicts of interest might corrupt
the directors and/or the business.
Corporate charter establishes a governance board of NEDs and a management
board of executives. Executives elected by cumulative voting with one vote per
share and NEDs with one vote per investor. NEDs control internal/external
auditors, director nomination and pay with veto powers when conflicts exist for
executives.
2 No creditable systematic process
for directors to determine when
their trust in management might
be misplaced.
Corporate charters makes provision for any class of stakeholders to elect a
representative board to meet with governors independently of management to
provide feedback and/or feed forward competitive intelligence to them and/or
managers.
3 Exposure to personal liabilities
and loss of reputation from
management misdeeds
Misdeeds of executives are the responsibility of the executives, as NEDs
(Governors) do not have power to manage business operations.
4 No systemic access to information
opposing management views and
so for evaluating management
independently of managers.
Feedback from establishment of one or more “Employee Assemblies”,
“Creditors Councils” and “Debtors Forums” who may appoint a “Stakeholder
Congress” to advise on KPI’s used to determine executive appointments and
their remuneration
5 No diversity of information
sources to cross check integrity of
management information or obtain
second or more opinions
Diversified feedback provided from specialized stakeholders groups and their
Boards with informal access to Government regulator who chairs their
Stakeholder Congress. Congress manages AGM that determines the pay and
election of NEDs & Executives.
6 Coping with data and information
overload
Compliance information and liabilities transferred to executives with option of
strategic analysis transferred to a supervisory board as found in Europe.
Systemic problems of
“best” practices for
directors
Systemic solutions from introducing network
governance used by nature
7 Difficulties in detecting
biases, errors and
omissions in reports from
managers
Access to a requisite variety of independent cross checking
sources of information to obtain accuracy as much as
desired as demonstrated by Shannon and Weaver (1949)
8 Inadequate knowledge for
complex decision making
Simplification of decision making by decentralization into to a
requisite variety of centers as described by Von Neumann
(1947)
9 Board decision-making
subject biases in its
membership – Gender
biases, etc.
Exposed to multiple diverse and contrary viewpoints raised
by stakeholders to force consideration of taboo topics and
avoid culture of don’t ask don’t tell.
10 Lack of will to act against
management
Governors (NEDs) no longer captive to management
information and/or powers and influence with independent
power and/or influence on executive pay and tenure
11 Lack of a systemic way to
safely blow the whistle on
errors, misdeeds, etc.
Provided privately by network of boards connected to the
government regulator and/or firm specific employee
ombudsperson
12 Impossibility of directly
controlling/countering
complex variables/risks
Control amplified indirectly through requisite variety of
stakeholders acting a co-regulators (Ashby 1957: 265)
Closing comments:
1) Growing appreciation that NEDs and audit committees are ineffectual, unethical, conflicted, counterproductive, for directors, shareholders and regulators.
2) Incremental de-regulation becomes possible to negotiable from demonstrating superior and creditable element of self-regulation.
3) I invite educators at universities and professional bodies to teach the 40 hour MBA unit I designed to teach how to become a self-governance corporate architect for the public, private or non-profit sectors.
© International Institute for Self-governance Slide No. 25
Illustration of Network Governance - 1 Mondragón Congress
established 1987
Fund for Intercooperative
Solidaridy (FISO) 1987
Group Governing
Councils
Central Social
Councils
Watchdog
Council
General Manager
(firs t 1970)
Supervisory Board
General
Manager
Social
Council
Delegate (s )
General Assembly of each of cooperat ive elect
representat ives to counci ls of their own co-op
& del egates t o parti cipat e i n General Assembl ies
of second order coops and Mondragón Congress
Council of Cooperative Groups established 1987
Management
Council
Elec
t
Ele
ct
Mondragón
Corporación
Cooperativa
(MCC 1990)
Citi zens who part icipate in Mondragón activit ies as cus tomers ,
suppli ers or community representatives
Nat ional government, regional government and town councils
Vot
e
Vot
e
Elect
League for
Education and
Cul ture (LEC)
(1948) Hezibide
Elkart ea (1988)
Acción Catól ica
(uti lised 1941)
Founder/Archit ect
Don José María
Arizmendiarriet a
1915-1976
Primary worker and
hybrid co-ops
associated into
12 groups
Manage
First co-op e s tabl ished 1956, wi th over 150 by 1992
Mem
ber
s
Del egate (s )
Executives
Nominate 1 of 3
for each vacancy
App
oint
Ele
ct
Nom
inat
e 1
of 3
fo
r ea
ch v
acan
cy
Ele
ct
Ele
ct
Work
place units
of 10-20
General Assembly of Group. Shares all or
part of surpluses, firs t est . 1960
Sources: CLP , 1992; MCC, 1992; Mollner 1991; Morrison 1991; Whyte & Whyte 1988
Vot e, appoint, delegate, manage: Advise or nominat e:
Rel
atio
nsh
ip A
sso
ciat
ion
or G
rou
p
Education (P PS)
Init iat ed by LEC 1943
Support Co-ops
Bank (CLP ) 1959
Retail (Eroski) 1969
R&D (Ikerl an) 1974
Social Securi ty
(Lagun-Aro) 1959
General Assembli es of
support co-ops made up
of delegates
Ent reprenuer 1959
(LKS-1990)
Start up:
(with dat es of est ablishment)
Pri
mar
y w
ork
er c
o-o
p
Work experience
(Alecop) 1966
Mondragón Corporacion Cooperativa (MCC).
12 Relationship Groups
150+ Primary cooperatives
60,000+ worker owners
Functions and activities of a unitary board (Tricker 1994: 245 & 287)
Long term Short term
Corporate policy • Approving budgets
• Determining compensation policy for
senior executives
• Creating corporate culture
Supervision • Reviewing key executive
performance
• Reviewing business results
• Monitoring budgetary control
and corrective actions
Internal
____________
Appointment and
rewarding chief
executive
Strategic thinking • Reviewing and initiating strategic
analysis
• Formulating strategy
• Setting corporate direction
Accountability • Reporting to shareholders
• Ensuring statutes regulatory
compliance
• Reviewing audit reports
External
Performance functions Conformance functions
Evidence of Network governance superiority
____________
____________
Decomposition of decision of making labor: Mondragón compound board compared with unitary board
TYPE MONDRAGON COMPOUND BOARD ANGLO
Control centers a
Watchdog Council
Supervisory board
Management Board
Social Council
Work Unit Unitary Board
Members 3 5-8 4-6 ~5-25 ~10-11 ~4-12
Functions Governance processes
Appoint Mgt. Board
Organise operations
Worker welfare
Production, elect Social
Council
Manage
Activities Efficacy & integrity of processes
Integrate strategic
stakeholders
Efficient allocation of
resources
Establish working
conditions
Job evaluation of pay rates
Direct & control
Internalb X X X X XXXX
Externalb X X XX
Short termb
X X X XXX
Long termb X X XX
27
aOmits General Assembly that elects Watchdog Council and Supervisory Board bDescriptions follow the typology of Tricker (1994: 244 & 287)